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The Use of Long-Term Finance by Firms and Households: Determinants and Impact

KEY MESSAGES

• From the perspective of the firm, long-term finance offers protection from credit supply shocks and from having to refinance in bad times, facilitating long-term investments and improving performance. Because it also shields firm managers from the frequent monitoring that short-term debt requires as it comes up for renewal, long-term finance can potentially hamper investment and performance.
• Empirical evidence suggests that use of long-term finance tends to be associated with better firm performance: with developed financial institutions and markets and the ability to enter into long-term contracts, firms can grow at faster rates than they could attain by relying on internal sources of funds and short-term credit alone. Consistent with these results, recent research also suggests that differences in corporate debt maturity had important real effects during the financial crisis of 2008¨C09. Although government subsidies and directed credit can lengthen the maturity structure, there is no evidence that such steps are associated with better firm performance.
• Even after controlling for firm characteristics¡ªsize, asset, industry composition, and profitability¡ª long-term finance is more prevalent among firms in high-income countries than in developing countries. Use of long-term finance by firms increases with a stable political and macroeconomic environment, better-developed financial systems, better information sharing, and sound legal institutions, including speedy contract enforcement, strong creditor rights, clear bankruptcy laws, and an effective corporate governance framework.
• Long-term finance allows households to meet different objectives throughout their life cycle. Younger households can accumulate wealth and reap term premiums through products such as bonds. Mortgages and student loans facilitate lumpy purchases of physical or human capital. Instruments such as annuities, insurance, and pensions can enable older households to insure against various life-cycle risks. Borrowing and investing in these markets also entail risks, however, and active government interventions to promote greater household participation may backfire, as in the case of U.S. subprime mortgages.
• All around the world, wealthier and more educated individuals are more likely to use longterm financial instruments as savers or borrowers. But even after accounting for individual characteristics, households¡¯ participation in long-term finance is higher in more-developed countries with a stable macroeconomic environment, low inflation, and sound legal systems. Mortgage markets develop only at relatively high levels of GDP per capita and often depend on the availability of long-term funding through the insurance sector or stock markets.
• Government policies to promote long-term finance for firms or households should focus on addressing markets failures; removing policy distortions and maintaining a stable macroeconomic environment; promoting competitive and stable financial institutions and markets through laws; and creating policies that regulate healthy entry, operations, and exit and that provide a strong institutional environment for contract enforcement.
• For firms, an effective corporate governance framework that improves shareholder rights can lessen reliance on short-term debt. Information sharing through credit bureaus can foster long-term finance by reducing information asymmetries between firms and lenders. Collateral registries for movable assets can help firms increase the amount of assets that they can post as collateral to obtain long-term loans. Appropriate contract law or leasing legislation can encourage leasing institutions to provide finance for fixed assets.
• For households, financial literacy, consumer regulation, disclosure rules, and the provision of investment default options can have important effects on increasing understanding of longterm finance instruments and on reducing financial mistakes stemming from lack of proper information and behavioral biases.

RELATED LINKS

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